While bond returns have astounded investors so far this year, many are left scratching their heads wondering if interest rates are ever going to rise creating the “Bond Armageddon” that has been so highly anticipated. On November 17th the Barclays US Aggregate Bond index total return has returned 5.13% year-to-date1. While that is certainly an attractive return on something that was destined to be down this year, municipal bonds have astounded even more. As of November 17th the Barclays Municipal total return index1 has experienced a cool 8.06% return. Is it time then to give up on municipal bonds after this return that seems like it should be unreal? The short answer is no.
Why not to give up on municipal bonds
The municipal bond market offers three unique traits that continue to make it attractive.
1. Taxes: Paying taxes are always a concern for investors, so the tax advantaged nature of municipal bonds continue to make them attractive, especially as tax rates increase for the wealthy.
2. Supply is limited: The chart below demonstrates how the number of municipal bonds available to purchase is getting smaller. The light teal bar below zero shows the amount of bonds each month that have been redeemed (called away or matured giving the investor their principal back). The purple bar above shows the number of new bonds being issued each month. The blue line shows the net number of issues or redemptions (number of new issues subtracting the number of redemptions). In most months over 2012 and 2013, the number is negative meaning the number of bonds out there for investors to purchase is getting smaller. A limited supply with demand that stays steady or increases can create positive returns for bondholders.
Source: Columbia Management
3. Yields: When comparing two bonds of similar quality (bond rating) and the municipal bond is yielding about the same or more and the interest is tax free2, which bond would you choose? Many investors have made that very same decision.
Three main things to consider before investing in municipal bonds:
- May provide a lower yield than comparable investments
- Are likely not suitable for investors who do not stand to benefit from the tax advantages
- Are subject to certain risks, including interest rate, credit, legislative, reinvestment and valuation risks
As with any investment, the decision to own municipal bonds is not one to be taken lightly. As always don’t hesitate to ask us to see if they make sense for your portfolio.
Angela Palacios, CFP®is the Portfolio Manager at Center for Financial Planning, Inc. Angela specializes in Investment and Macro economic research. She is a frequent contributor to Money Centered as well asinvestment updates at The Center.
1: Source: Morningstar Direct. Barclays US Aggregate Bond Index represents investment grade bonds being traded in United States. Barclays Municipal total return index represents the broad market for investment grade, tax-exempt bonds with a maturity of at least one year. Individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance does not guarantee future results.
2: Municipal bond interest is not subject to federal income tax but may be subject to AMT, state or local taxes. Income from taxable municipal bonds is subject to federal income taxation; and it may be subject to state and local taxes. Please consult an income tax professional to assess the impact of holding such securities on your tax liability.
The market value of municipal bonds may fluctuate and, if sold prior to maturity, the price you receive may be more or less than the original purchase price or maturity value. There is an inverse relationship between interest rate movements and fixed income prices. This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Center for Financial Planning, Inc. and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. C14-036843